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Quite Concerned

There once was a banker named Mark
Who four months ago sounded stark
In warning that rates
Might rise at more dates
As UK growth steepened its arc

But yesterday morning we learned
The BOE was quite concerned
The growth they expected
Could not be detected
And so any rate hike was spurned

There is a new narrative evolving, but as it remains early days the accuracy of this narrative is going to be called into question periodically. Yesterday was a perfect example. In the old narrative, synchronous global growth was the theme alongside dormant inflation pressures in the US with the two factors leading to the Goldilocks economy of strong growth, low inflation and no urgency to increase policy interest rates. But all of that started to sound less plausible once it became clear that, at least in Q1, synchronous global growth was actually strong US growth with many laggards, and Fed commentary hewed more hawkish than had previously been expected. The results have been evident over the past month with the dollar moving higher amid rising inflation, (and by extension interest rate) expectations, combined with weaker than expected foreign data. This has caused interest rate differentials to increase in the dollar’s favor.

One of the key reversals has been in the UK, where back in February, Governor Carney sounded extremely hawkish, explaining to the market that rates would likely rise more, and more frequently than had been expected at that time. The market promptly repriced and expectations for a hike yesterday rose as high as 90% at one point. Alas, the data never supported Carney’s thesis, showing the UK economy slowing sharply and the Brexit negotiations made no significant progress thus adding further uncertainty to the situation. As this unfolded, Carney walked back his earlier hawkishness and now the question is will the BOE still find it appropriate to raise rates this year at all? My gut tells me that they will not and that as the Fed continues on its merry way, the pound will continue to suffer. Yesterday’s market response to the MPC vote showed an initial dovish read with the pound falling sharply on the news (-0.7%), but then recovering most of that ground before the close and the rest of it this morning. So as I type, the pound is exactly where it was just before the MPC announcement.

Of course, the question is, why did the pound rebound yesterday? And that is down to the other part of the recent narrative that did not hold to form, US inflation. Yesterday’s CPI data was lower than expected with headline rising 0.2% (2.5% Y/Y) but core rising only 0.1% (2.1% Y/Y), a tick lower than expected. Now my good friend Mike Ashton, (@inflation_guy) whom you all should follow if you are interested/concerned about inflation, pointed out that the low print was driven by used car prices, which fell quite sharply. That is pretty aberrational and likely not indicative of the inflation story, which showed that things like medical expenses, housing and apparel all continued their trajectory higher. However, the market saw the headline, breathed a sigh of relief, and bought stocks and bonds while selling the dollar. That outcome is directly in opposition to what the new narrative is supposed to explain, and there were many who were quick to highlight how the old narrative was really still holding sway.

The thing is, as central banks, and thus market participants, focus more keenly on each data point, surprises in those data points are going to result in market responses. For what its worth, my take is that the new narrative remains a better description of the current market situation, and that it has further to evolve. In other words, I expect to see US growth outpace the rest of the world’s for a little while longer, US inflation to continue be felt and the Fed to continue its hawkish sentiment, all of which leads to the dollar continuing to climb. Adding to that is the oil picture, which because it seems to be rising on supply issues, rather than demand issues, is actually supporting the dollar through the inflation connection. In other words, its not that demand is so great it is driving oil prices higher thus leading to its own self-moderation of higher production, but the fact that concerns about Venezuela’s oil production continuing to slip and worries about the impact of the US withdrawing from the Iran nuclear pact on potential Iranian output that are driving prices higher, thus impacting inflation more directly.

So given that extremely messy backdrop, the dollar this morning is mildly extending the selloff that started in the wake of the CPI data. Looking across the G10, the pound is today’s biggest winner; rallying 0.4% to fully regain the BOE induced losses yesterday. As to the rest of the group, movement has been much smaller, on the order of 0.1%-0.2%. There has been very little data of note overnight to drive things, which is arguably one of the reasons that movement has been so muted. Switching to the EMG bloc, other than the Turkish lira, which continues its slow-motion collapse falling 1.1%, the dollar is modestly softer. However, while there are clearly a growing number of idiosyncratic stories regarding currencies in this bloc (TRY, ARS, IDR, MYR) each of which has led to sustained weakness, the bulk of the bloc continues to trade as per the dollar overall. So strong dollar days impact all of them similarly, and weak dollar days do the same thing. Today happens to be a weak dollar day. But not excessively so.

The only data of note this morning is the Michigan Confidence report (exp 99.0), but that is rarely a market mover. St Louis Fed President Bullard speaks at 8:30, which has potential to move things, but as he is already a known dove, it is unlikely that dovish comments from him regarding yesterday’s CPI will have much impact. If he were hawkish, however, that would be a different story. Looking it over, and with the weekend fast approaching, I would say we are far more likely to see the dollar continue to soften today as those traders who have jumped on the strong dollar bandwagon lately will be more likely to take profits ahead of the weekend and with the CPI data still ringing in their ears. But the medium term trend of a stronger dollar remains fully intact in my view.